Cheap Stocks for 2014: Tech's Best Buys

Looking for a deep-discount value play in the tech sector? The market is littered with cheap stocks for 2014. Some tech stocks are cheap for good reason while others seem spring-loaded for a huge bounce next year. Here are three of tech's best buys right now.

Rackspace Hosting raced to all-time highs last January, but then disappointed on three of its next four earnings reports. Rackspace shares have fallen 53% year to date, creating this interesting five-year chart:

The stock suffered in 2013 as rampant revenue growth failed to pull earnings along for the ride. Sales are growing at a 15% annual rate while trailing earnings are down 40% year over year.

But that's a conscious decision, said Rackspace CEO Lanham Napier in the third-quarter conference call last month. The cloud computing pioneer is all about top-line growth right now, far more important than bottom-line earnings at the moment. "We've said throughout 2013 that our No. 1 financial objective has been to accelerate our growth rate," Napier said.

To reach Napier's 20% revenue growth target in 2014, the company needs to do a better job of explaining what's different and better about the all-important OpenStack cloud computing solution. The OpenStack product is already a big deal as a cloud platform, and Napier sees it becoming equally important as a revenue driver. "However, we don't believe we've yet proven this to the market," he said.

So the top job for Lanham Napier and Rackspace in 2014 is to educate investors about the business value of an open cloud computing platform. Do that, and the stock will bounce back to those stratospheric January levels and beyond.

Red Hat has already proved that there's investable value in open software. Red Hat's eponymous operating system is just as free (as in speech and as in beer, unless you're buying enterprise-level support contracts) as Rackspace's OpenStack. Open software is all Red Hat does, after all.

Here's another company hell-bent on driving massive sales growth. Red Hat investors have been richly rewarded over the past five years, even though the market enthusiasm ran dry in 2013. Share prices have fallen 12% year to date.

Both Red Hat and Rackspace have more than doubled their sales over the past five years, setting the stage for huge earnings and cash flows when the companies shift out of high-growth mode. By reducing their sales and marketing budgets and nixing other growth-oriented programs, both of these companies can leverage their margins and watch the stocks follow suit.

This won't happen in 2014, of course, but you're looking at a mighty fine entrance point on both Red Hat and Rackspace right now. The rewards might be delayed, but fortune favors the prepared.

Let me round this list off with a different kind of value play. IBM shares have plunged 10% year to date and trade 20% below the all-time highs that were set in March this year.

This is no damn-the-torpedoes growth story, but a downright secular tech giant in the middle of yet another game-changing transformation. This time, Big Blue is moving away from low-margin hardware sales to refocus on software and services. Once again, cloud computing is a major theme.

Change is always tough, and this particular transformation hurts. IBM is letting hardware sales go to the competition in exchange for higher margins, and the net effect hasn't had a blindingly obvious positive effect on the bottom line yet. IBM also misjudged the market impact of recent changes in the Chinese economy, further damaging the revenue line.

But you know, IBM has been here before. The company that built the first PC traces its computing industry history back to punch cards and mechanical tabulators. Obsolete products are nothing new to IBM, and the company has always adjusted to the changing times. This time is no different.

Expect IBM shares to roar back to life in 2014 as the software-based makeover starts to pay real dividends. Panic-selling a hundred-year survivor on a couple of soft quarters is always a bad idea, but buying in while other investors are selling can make you rich.

So those are my top three best buys in tech for 2014: two high-flying growth plays and one misjudged giant. Do you agree? Disagree with a vengeance? Share your thoughts in the comments box below, either way.

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